Picassos In The Pileup?

Written by John Osbon on September 1, 2015

Gold wants love, but gets none. Japan is dying for affection, but gets none. In recent weeks we’ve discussed these lonely asset classes and why they still belong in most portfolios. What’s next – and last – on the wallflower roster? Are there valuable assets here waiting to be scooped up while no one cares? Read on.

Ugly ducklings
Emerging markets are definitely investment orphans now. They’ve been unloved for at least four years since the April 2011 peak, drifting steadily downward after compounding aggressively in the ‘00s. More recently the unloving has turned to injury since the August 19 market rout began.  Using BlackRock’s big EEM exchange traded fund as a proxy, emerging markets are down 22 percent from this year’s April peak. It gets worse. EEM is down 40 percent from its all-time October 2007 high. By contrast think of how well your US stock investments have done over the last five years.

Too big to ignore and more profitable than you thinkACG_pile_of_paintings-P1050585
Emerging markets sound small, but aren’t at all. Conventional research suggests that emerging markets comprise 12 percent of all the stock market value in the world.  Some, including the Windham experts, put the number at 25 percent. With China, Brazil, South Korea, India, Russia and South Africa counted among emerging economies, it’s a big sector, far too big to ignore, avoid or write off.

Let the cash flow to you
Emerging markets come in many flavors: small, big, growth and income, among others. It is not well known that emerging market stocks are also dividend rich, paying out over $150b worldwide per year according to our friends at WisdomTree. EEM’s current yield is 2.49 percent. Getting paid while you wait for price appreciation provides some solace.

There once was love. Lots of it.
EEM debuted on April 1, 2003. Since then the ETF has returned 10.68 percent annually versus DIA (the Dow) at 8.26 percent. Both are very nice compounding numbers. But the more recent story has been bleak. Down, down, and down. What that means, like for gold and for Japan, is that you can own emerging markets at yesteryear prices, like 2006. And we believe most investors should. There may be some Picassos in there somewhere.

Why so unloved?
It is not necessary to know why emerging markets are so unloved, although there are many fingers to pointing out why. Slowing growth, high debt, risk, corruption, and a lack of transparency. In a classic case of piling on, FT reports ‘Surge in emerging market capital outflows…‘. The list goes on and on. We know that. We expect, in fact seek, greater risk for the greater potential return. Investors around the world are waiting for that return to start returning.

Test your emotional intelligence
As the FT article indicates, many investors are bailing out of emerging markets. I understand that instinct, but also see it as running for the store exits when the big sale is announced. One of the tenets of modern portfolio theory is to own “the market” – meaning not just the Dow, but representative holdings across the entire global marketplace. With the size of emerging economies, we see them as must-own for most investors. That means buying an asset class that no one loves right now, at historically low prices. If you already own emerging markets and your allocation has shrunk with falling prices, it means buying more to rebalance.

Not the guidance you may want to hear right now, but to get the benefits our advice is: stay diversified, balanced and invested even when your heart wants to head for the hills. We know this can be a tough route to take. We’d be happy to talk to you about it.

John Osbon – josbon@osboncapital.com


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